I have a habit, or so my wife tells me, of staring intently, for minutes at a time, into an open refrigerator, in search of one particular item. When she can no longer stand it, or when the binging of the refrigerator alarm informs the world that its contents are now thawing, she gently asks me what I am looking for and points it out, sitting, as it always is, right in front of my nose.
I had a similar feeling of sheepish embarrassment last week, when I reflected on the impact of the extraordinary surge in wealth on the economic and financial environment. I spend a significant chunk of my life looking at stock indices and home prices. And yet, throughout this year, while agonizing about tenths of a percent in the unemployment rate or the inflation rate and how the Fed might interpret them, I have neglected to consider fully how burgeoning stock market and housing wealth has changed both the economic environment and the position of investors.
The Surge in Wealth
Let’s start with the raw numbers.
We currently estimate that the net worth of American households rose by $2.8 trillion in the third quarter to a record $157.2 trillion, or roughly $446,000 per head. Total net worth is up 11% over the past year and 47%, (or a staggering $50.1 trillion), over the past five years, easily outpacing an estimated 23% increase in consumer prices and a 35% increase in personal income over the same period.
This wealth surge has come from both stocks and housing.
Over the past five years, household financial wealth has risen by 38%, to $120.4 trillion, while the value of home equity has climbed by 83%, to $35.1 trillion. To put that last number in perspective, there are roughly 87 million U.S. homeowners today, compared of 79 million five years ago. Consequently, we estimate that the average American homeowner now has over $400,000 in home equity compared to $240,000 five years ago. While a large chunk of these gains have accrued to older home-owners who have paid off their mortgages, the biggest percentage gains have been achieved by those who bought homes with low-rate mortgages in the last two decades and, who, because of the leverage implicit in mortgage finance, have seen home equity gains far outpace even very large increases in home prices.
Nor is this just a recent experience. While the last five years have seen particularly balanced gains in wealth across financial and real assets, the net worth of American households has been rising strongly for many years. From the 1950s to the mid-1980s, the ratio of the net worth of households and non-profit organizations to nominal GDP fluctuated in a relatively narrow range of between 3.2 and 3.9 times. Since then, it has risen very steadily and, we estimate, hit 5.7 times in the third quarter of this year – an all-time high, if you exclude the very distorted years of the pandemic.
The Causes of the Wealth Surge
That’s a lot of numbers – but what is behind them?
When it comes to equities, the story, of course starts with earnings. The adjusted after-tax profits of all American corporations were fairly steady in a range of 5%-8% of GDP from the late 1940s to the early 1990s. Since then, they have increased steadily and, we estimate, will come in at 10.9% of GDP in the third quarter of this year. Broadly speaking, this has occurred due to declining GDP shares for corporate taxes, interest and compensation over the same period, reflecting, respectively, more favorable tax treatment, declining inflation and interest rates and diminished union power. Moreover, interest rates have served double-duty in the surge in equity wealth as a long-term decline in interest rates has enhanced the future value of all cash flows, including the future earnings of corporations. This has allowed P/E ratios to rise steadily in recent decades, albeit with significant drops in the bear markets of the 1970s and 2000s.
Home equity has also seen very strong gains over the decades, apart from the sharp decline in the Great Financial Crisis. A long period of low interest rates after that crisis obviously helped but so did low levels of construction, as lenders applied much tougher standards to home-builders and home-buyers alike. The share of U.S. homes that are vacant and for sale declined from 2.9% in 2008 to just 0.9% by the second quarter of this year, tying a record low for this series going back to the 1960s. This lack of housing on the market has helped sustain home prices even as mortgage rates have risen to more normal levels. However, the wealth surge has also helped, as parents with significant gains in housing and equity wealth have been better able to assist their children in buying homes.
Macroeconomic Impacts of the Wealth Effect
The wealth surge is having important effects on the economic environment.
First, it is helping sustain consumer spending. In theory, the $50 trillion gain in household wealth over the past five years could fund two and a half years of consumer spending. Of course, in practice, the vast majority of this wealth is not being used for that purpose. However, it does act as collateral for borrowing, particularly for richer and older households.
The gain in home equity should also be a powerful force in muting consumer credit problems. One of the underlying economic problems in the Great Financial Crisis was that households had so little home equity that, in many cases, it made sense to default and hand the keys back the bank. Today, homeowners have better options.
These gains in wealth should also reduce worries about retirement. In a survey conducted in January by the Employee Retirement Benefit Institute, just 21% of workers said that they were very confident about having enough money in retirement, up from 18% the year before but down from a record high 29% at the start of 2021. However, with inflation falling and the S&P500 now up by more than 30% year-over-year, this confidence should improve further by next January’s survey, a real psychological boost at a time of general consumer gloom.
There are, of course, some important limitations and drawbacks to the wealth surge.
First, it is not being felt evenly. Indeed, the one third of American families that rent rather than own their home have experienced none of the real estate gains and very little of the increase in stock market wealth. In addition, higher home prices have put the dream of home ownership even more out of reach for many American families.
Second, increased household wealth has come at a time of rising government debt. Indeed over the same five year period that saw a $50 trillion increase in household wealth, federal government debt rose by over $11 trillion. This additional debt is, for macro-economic purposes, a liability of the household sector since it will, eventually, have to be paid for by taxes.
Third, a surging U.S. stock market has attracted foreign capital, contributing to a higher dollar and a more-or-less permanent U.S. trade deficit. While the trade deficit may seem like a somewhat esoteric concept, its practical impact has been to undermine U.S. manufacturing employment and wages while gradually increasing our foreign debt.
Finally, as all of these themes have played out, they are contributing to greater inequality and a rise in populist politics. This political trend could ultimately lead to decisions that are damaging both to the economy overall and wealth accumulation in particular.
Investment Implications
Notwithstanding these concerns, investors have reasons to celebrate the wealth surge. While celebrating, though, they would be wise to consider what it means for their investment strategy.
First, they should recognize that the most recent leg of stock and bond markets gains have been fueled largely by rising valuations rather than long-term improvements in profit and inflation fundamentals. Moreover, these rising valuations, for the most part, have been concentrated in just one small sector of the U.S. equity market, namely mega-cap tech stocks. This should both limit potential gains going forward and increase the potential for a significant market decline.
Second, for many, now would be a good time to review their overall objectives and risk tolerance. Recent gains in markets will have allowed many to accumulate enough wealth to achieve their primary lifestyle goals of just a few years ago, which, most often, were to be able to fund a comfortable retirement. If this is the case, it may well be time to take some risk off the table by locking in gains rather than increasing risk by allowing a rising exposure to indices that have become more unbalanced and richly valued.
In short, while investors, economists and policy makers should recognize and celebrate the wealth surge, this change in the landscape is a reason to reassess strategies rather than to passively sit back and appreciate the appreciation.